Wk 10 Risk and Financial Derivatives

Question 1

What are Derivatives?

Answer 1

Financial Instruments whose value is derived from an underlying asset

Question 2

What are the most common underlying assets for financial derivatives?

Answer 2

• Commodities
• Shares, bonds, indicies
• Currencies, interest rates

Question 3

What instruments do Derivatives include?

Answer 3

• Forwards
• Futures
• Options
• Swaps

Question 4

What are Forwards?

Answer 4

Agreement to buy/sell a fixed quantity of a particular commodity at a future date at a fixed price

Question 5

Features of Forwards?

Answer 5

• Mostly tailor made
• Cash changes hands at maturity, not striking
• Changes of price agreement and actual transaction creates losses/ profit for different parties
• Risk of default substantial (usually takes place between close parties)

Question 6

Features of Futues?

Answer 6

• Same as forwards in nature
• standardized agreements
• Contract periods usually 30,60,90 days
• Traded on exchanges not OTC

Question 7

Features of CFDs?

Answer 7

• Same as futures/ forwards in nature
• No fixed expiry date
• UK version of futures for retail investors
• No physical delivery involved
• Brokers/ exchanges act as market maker/ intermediary

Question 8

What are Options?

Answer 8

Option give the holder the right, but not the obligation, to buy or sell a specified quantity of an asset at agreed price on or before a specified date

Question 9

Types of Options?

Answer 9

• Call
• Put

Question 10

What are Swaps?

Answer 10

• Exchange of cash payment obligations
• Can be based on many different cash flows
• Two basic types: Interest Rate Swaps, Currency Swaps